Income Inequality, Poverty, and Discrimination Chapter 20 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Objectives Income inequality in the U.S. Sources of income inequality Income inequality since 1970 Economic arguments regarding income inequality Poverty measurement and incidence The U.S. income-maintenance program Labor market discrimination 20-2

Facts About Income Inequality Average household income –$66,570 in 2006 –Among highest in the world Distribution by quintiles Income mobility –People change quintiles Government redistribution –Taxes and transfers 20-3

Facts About Income Inequality (1) Quintile (2) Percentage of Total Income Lowest 20% Second 20% Third 20% Fourth 20% Highest 20% Total Distribution by Quintiles, Source: Bureau of the Census (3) Upper Income Limit $20,035 37,774 60,000 97,032 No Limit 20-4

Income Inequality Lorenz Curve and Gini Ratio Perfect Equality Lorenz Curve (Actual Distribution) Complete Inequality A B a b c d e f Gini Ratio = Area A Area A + Area B Percentage of Households Percentage of Income 20-5

Government Redistribution Lorenz Curve Before Taxes and Transfers Percentage of Households Percentage of Income Lorenz Curve After Taxes and Transfers Impact of Government Taxes and Transfers 20-6

Causes of Income Inequality Ability Education and training Discrimination Preferences and risks Unequal distribution of wealth Market power Luck, connections, and misfortune 20-7

Income Inequality Over Time Rising income inequality since 1970 Causes of growing inequality –Greater demand for highly skilled workers –Demographic changes –International trade, immigration, and decline in unionism 20-8

Income Inequality Columbia Brazil South Africa Guatemala Mexico United States Italy Japan Sweden Germany Source: United Nations, Human Development Report, 2007/2008 Percentage Total Income Received by Top One- Tenth of Receivers, Selected Nations

Equality Versus Efficiency The case for equality –Maximizing total utility The case for inequality –Incentives and efficiency The equality-efficiency tradeoff 20-10

The Utility-Maximizing Distribution of Income Anderson’s Marginal Utility From Income Brooks’ Marginal Utility From Income 00 Marginal Utility Income $5000 $2500 $7500 MU B MU A a a’ b’ b Utility Gain (Entire Blue Area) Utility Loss (Entire Red Area) Equality Versus Efficiency 20-11

The Economics of Poverty Definition of poverty 2006 –Single person < $9,800 –Family of 4 < $20,000 –Family of 6 < $26,800 –36.5 million Americans –Poverty rate 12.3% 20-12

Incidence of Poverty Female Householders African Americans Hispanics Foreign-Born (Not Citizens) Children Under 18 Women Total Population Asians Whites Men Persons 65 or Over Married-Couple Families Full-Time Workers Poverty Rates Among Selected Population Groups, 2006 Source: Bureau of the Census,

The Economics of Poverty Poverty rate trends –Significant decline –Stable in 11-13% range since –Rises with recession Measurement issues –Arbitrary threshold –Consumption vs. income 20-14

Income-Maintenance System Entitlement programs –All those eligible receive aid Social insurance programs –Social security and Medicare –Unemployment compensation Public assistance programs –Welfare 20-15

Public Assistance Programs Supplemental security income Temporary assistance for needy families Food stamp program Medicaid Earned Income Tax Credit 20-16

Discrimination Inferior treatment Taste-for-discrimination model –Prejudice people receive disutility –Willing to pay to avoid –Discrimination coefficient –Prejudice and the market African- American-White wage ratio –Competition and discrimination 20-17

Taste for Discrimination Model African-American Wage Rate (Dollars) African-American Employment (Millions) 0 D3D3 D2D2 D1D1 S $9 8 More Discrimination Less Discrimination 20-18

Discrimination Statistical discrimination –Judged on average group characteristics –Labor market example –Profitable, undesirable, but not malicious 20-19

Discrimination Occupational segregation –The crowding model –Crowd certain groups into less desirable occupations –Effects of crowding –Elimination of crowding Discrimination 20-20

Occupational Segregation Wage Rate BBB M M W DxDx DyDy DzDz Occupation X Occupation Y Occupation Z Quantity of Labor (Millions) Quantity of Labor (Millions) Quantity of Labor (Millions) By crowding women into one occupation (Z)… Men enjoy higher wages in the other occupations (X and Y)

U.S. Family Wealth Median and Average Family Wealth, In 2004 Dollars YearMedianAverage $70,800 83,100 91,700 93,100 $260, , , ,200 Family wealth rose rapidly between 1995 and

Family wealth became more unequal between 1995 and 2004 Percentage of Total Family Wealth Held by Different Percentile Groups, % % YearBottom 90%Top 1%Bottom 10% Percentile of Wealth Distribution 67.8% U.S. Family Wealth 20-23

Key Terms income inequality Lorenz curve Gini ratio income mobility noncash transfers equality-efficiency trade- off poverty rate entitlement programs social insurance programs Social Security Medicare Unemployment compensation public assistance programs Supplemental Security Income (SSI) Temporary Assistance for Needy Families (TANF) food-stamp program Medicaid earned-income tax credit Discrimination (EITC) taste for discrimination model discrimination coefficient statistical discrimination occupational segregation 20-24

Next Chapter Preview… The Economics of Health Care 20-25